Question 1

The key to understanding the money creation process is the fact that:

Accepted Answer

The correct answer is B because when banks issue loans, they create a liability for themselves (the loan amount they owe in terms of providing cash if the borrower decides to withdraw) and an asset for the individual (the deposit in the borrower's account, which is considered money). This process increases the money supply without physically printing more currency.

Question 2

For every financial asset there is a:

Accepted Answer

For every financial asset, there is a corresponding financial liability. This is because financial assets (like loans given, bonds, or deposits) represent a claim on another party, which in turn is a liability for that party.

Question 3

The amount of money ultimately created per dollar deposited is the:

Accepted Answer

The money multiplier refers to the amount of money that banks can generate with each dollar of reserves, reflecting the total increase in the money supply from an initial deposit.

Question 4

Real assets are created by:

Accepted Answer

Real assets are created through real economic activities, such as the construction of a house, which involves the production or acquisition of tangible assets.

Question 5

Suppose the banking system has $100,000 in outstanding deposits and actual reserves of $35,000. If the required reserve ratio is 25 percent, the maximum amount the banking system can now add to the money supply is:

Accepted Answer

The required reserves are 25% of $100,000, which is $25,000. The bank has $35,000 in actual reserves, so it has $10,000 in excess reserves. With a reserve ratio of 25%, the money multiplier is 4 (1/0.25). Therefore, the maximum amount the banking system can add to the money supply is $10,000 * 4 = $40,000.

Question 6

Suppose the required reserve ratio is 0.15. Total bank deposits are $100 million and the bank holds $20 million in reserves. How much more money can the bank create if it does not hold excess reserves?

Accepted Answer

The bank can create additional money based on the excess reserves it holds. The excess reserves can be calculated as the actual reserves minus the required reserves. Required reserves = 0.15 * $100 million = $15 million. The bank has $20 million in reserves, so the excess reserves are $20 million - $15 million = $5 million. The money multiplier is 1 / reserve ratio = 1 / 0.15 = 6.67. Therefore, the bank can create additional money = excess reserves * money multiplier = $5 million * 6.67 = $33.35 million, which is approximately $33 million.

Question 7

Excess reserves equal:

Accepted Answer

Excess reserves are the amount of reserves a bank holds beyond the minimum required by the central bank. They are calculated as total reserves minus required reserves.

Question 8

The reason why the banking system can increase checkable deposits by a multiple of initial deposits is that:

Accepted Answer

The banking system can increase checkable deposits by a multiple of initial deposits because borrowers typically spend most of the loan they receive, and these funds are then deposited into other accounts, creating a multiplier effect through the banking system. This process allows banks to create more money in the form of checkable deposits than the original amount of reserves.

Question 9

Given a required reserve ratio of 20 percent for all banks, total bank reserves of $300 billion could support maximum deposits of:

Accepted Answer

The maximum deposits supported can be calculated using the formula: Maximum Deposits = Total Reserves / Reserve Ratio. Here, $300 billion / 0.20 = $1,500 billion.

Question 10

Given a required reserve ratio of 10 percent for all banks, total bank reserves of $400 billion could support maximum deposits of:

Accepted Answer

The answer of Given a required reserve ratio of 10...

Question 11

If people hold onto money as cash rather than depositing it, the money multiplier will:

Accepted Answer

The money multiplier gets smaller because holding onto cash means less money is deposited in banks, which in turn means banks have less base money to support the creation of new loans. This reduces the overall money supply that could be created through the banking system's lending activities.

Question 12

Suppose the banking system has $100,000 in outstanding deposits and actual reserves of $35,000. If the required reserve ratio is 20 percent, the maximum amount the banking system can add to the money supply is:

Accepted Answer

The answer of Suppose the banking system has $100,000 in...

Question 13

The amount of reserves in the economy is often determined by the amount of money in the economy that will achieve a particular interest rate. This reflects the fact that the money supply is:

Accepted Answer

The money supply is considered endogenous because it is determined by the demand for money which, in turn, influences the interest rate. Central banks adjust the amount of reserves in the economy to target specific interest rates, reflecting the responsive nature of the money supply to economic conditions.

Question 14

What is exchanged in the financial sector?

Accepted Answer

Financial assets encompass a broad range of items beyond just money, including stocks, bonds, loans, and more, which are all exchanged in the financial sector.

Question 15

If a deposit of $50 in the banking system can lead to a maximum expansion in bank deposits of $250, using the money multiplier formula, the required reserve ratio must be:

Accepted Answer

The money multiplier formula is 1/required reserve ratio. If $50 leads to a maximum expansion of $250, the multiplier is 250/50 = 5. Therefore, the required reserve ratio is 1/5 = 0.20 or 20%.

Question 16

Which of the following do policy makers tend to target when setting monetary policy?

Accepted Answer

Policy makers, particularly central banks, often target interest rates as a primary tool for setting monetary policy to influence economic activity, inflation, and employment.

Question 17

Why is it difficult for policy makers to rely on the theoretical discussion of the money multiplier to target the money supply?

Accepted Answer

The money multiplier theory assumes a stable relationship between the monetary base and the money supply, primarily through the banking system's lending activities. However, in practice, the amount of excess reserves (funds banks hold beyond the required minimum) and cash in circulation can fluctuate significantly due to various factors such as economic conditions, regulatory changes, and banks' own lending decisions. These fluctuations make it difficult for policymakers to predict or control the money supply accurately through the money multiplier concept.

Question 18

When people hold financial assets in the form of money, they:

Accepted Answer

Holding financial assets in the form of money typically means keeping cash or in non-interest-bearing accounts, which results in forgoing the opportunity to earn interest that could be obtained through other financial investments.

Question 19

What is produced and exchanged in the real sector?

Accepted Answer

The real sector of an economy involves the production, exchange, and consumption of goods and services, as opposed to the financial sector which deals with monetary transactions and financial assets.

Question 20

After there has been a change in bank reserves, the multiplier process continues until:

Accepted Answer

The multiplier process continues until each bank holds its desired reserve-to-deposit ratio, ensuring that banks have enough reserves to meet their regulatory requirements and manage withdrawals while also maximizing their ability to create loans.

Quiz 28: The Financial Sector and the Economy